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Personal Finance:A Gospel Perspective

Budgeting and Measuring Your Financial Health

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Objectives

A. Develop and Implement a Budget

B. Calculate your Net Worth (wealth) using a Balance Sheet

C. Develop a personal Income Statement and use it to analyze your spending

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Your Personal Financial Plan

Your Personal Financial Plan will include:Section III. Personal Financial Statements:• Personal Balance Sheets from the first and

third months of the semester• Personal Income Statements from the first

and third months of the semester• Personal financial ratios from the first and

third months of the semester • Comments on your financial statements and

ratios and how you did over the semester

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Your Personal Financial Plan

Section IV. Budgets:• Budgets will be handed in at the end of each of the

first two months, with the third month handed in with the PFP.

• Budget, actual, and differences for month 1, with written explanations and reasons for differences.

• Budget, actual, and differences for month 2, with written explanations and reasons for differences.

• Budget, actual, and differences for month 3, with written explanations and reasons for differences.

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A. Develop and Live on a Budget

President Spencer W. Kimball said:

• “Every family should have a budget. Why, we would not think of going one day without a budget in this Church or our businesses. We have to know approximately what we may receive, and we certainly must know what we are going to spend. And one of the successes of the Church would have to be that the Brethren watch these things very carefully, and we do not spend that which we do not have. (April 1975 General Conference)

• If the brethren watch these things very carefully in the church, shouldn’t we in our homes?

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Budgeting (continued)

What is a Budget?• It’s the process of making sure your resources are used for

the things that matter most—your personal goals

• A budget is a star to set your sights by, not a stick to beat yourself with.

• It’s only a tool, but an important one!

• While a budget is easy to understand, it takes discipline to follow.

• It is probably the most important single factor in helping you to attain your personal goals.

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Budgeting (continued)

• The Budgeting Process• 1. Track your expenses• 2. Develop your cash budget• 3. Implement your budget• 4. Compare it to actual expenses, then make

changes where necessary to achieve your goals

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1. Track Expenditures

There are different methods to track spending:• Checks and credit cards

• These expenditures leave a paper trail

• Cash

• Record expenditures in a notebook

• Computer programs, i.e., Quicken, Money

• These are very useful, especially if tied to bank and credit card companies

• They are a great investment which can save much time if done well and set up properly

• Generate a monthly income/expense statement

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2. Develop and Implement A Cash Budget the Right Way

What is a Cash Budget?• A plan for controlling cash inflows and outflows

• Its purpose--To balance income with expenditures AND savings

Income:

• Examine last year’s after-tax total income and make adjustments for the current year.

Expenses:

• Identify all fixed (non-discretionary) and variable (discretionary) expenditures

• Look for ways to reduce your variable expenses.

• Reduce interest payments—pay off debt

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Budgeting: The Old Way

Available for Savings

Personal Goals

Income ExpensesTithing

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Budgeting: The Better Way

Income Expenses

Personal Goals

OtherSavings

Pay the

LordPay

Yourself

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The Better Line of Thought

Before, you paid the Lord first, lived on the rest, and whatever was left at the end of every month went into savings.• Your priorities were wrong

Now, pay the Lord first, yourself second, and then live on the rest.• Your priorities are now in order

• And now you have twice the chance of achieving your personal goals

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The Better Way (continued)

President Gordon B. Hinckley stated:• In managing the affairs of the Church, we have tried to

set an example. We have, as a matter of policy, stringently followed the practice of setting aside each year a percentage of the income of the Church against a possible day of need. I am grateful to be able to say that the Church . . . is able to function without borrowed money. If we cannot get along, we will curtail our programs. We will shrink expenditures to fit the income. We will not borrow. (Gordon B. Hinckley, “To the Boys and to the Men,” Ensign, Nov. 1998, 51.)

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The Better Way (continued)

Elder L. Tom Perry affirmed this when he said:• After paying your tithing of 10 percent to the Lord,

you pay yourself a predetermined amount directly into savings. That leaves you a balance of your income to budget for taxes, food, clothing, shelter, transportation, etc. It is amazing to me that so many people work all of their lives for the grocer, the landlord, the power company, the automobile salesman, and the bank, and yet think so little of their own efforts that they pay themselves nothing. (L. Tom Perry, “Becoming Self-Reliant,” Ensign, Nov. 1991, 64.)

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3. Implement your Cash Budget

Try the budget for a month• Record all income and expenses in the

proper category by date• Sum all days or columns• Note how much you have available in each

category at the end of each week• Adjust the plan or expenses as necessary to

maintain the plan• Try to be as financially prudent as possible

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4. Compare budget to actual expenses and make changes where necessary

Compare your budget to actual• Adjust the plan or your expenses as necessary to

maintain the plan

• Don’t reduce payments to the Lord or yourself If all else fails, this system will work!

• The Envelope System:

• Put money for each expense in an envelope

• When the money is gone, its gone

• It forces you to make it work (no cheating)

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Budgeting Summary

If someone does not know where they are, the best map in the world will not help them get where they want to go. A budget is your road map.• A budget is a plan for controlling cash flows,

specifically income, savings, and expenses. It requires accurate record keeping

• The budget should accurately match a household’s financial abilities with its personal financial goals. It tells where you want to be.

• We have been commanded by our leaders to have a budget.

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Final Remarks on Budgeting

Elder Marvin J. Ashton stated:• Some claim living within a budget takes the fun out

of life and is too restrictive. But those who avoid the inconvenience of a budget must suffer the pains of living outside of it. The Church operates within a budget. Successful business functions within a budget. Families free of crushing debt have a budget. Budget guidelines encourage better performance and management. (italics added, Marvin J. Ashton, “It’s No Fun Being Poor,” Ensign, Sept. 1982, 72.)

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Questions

Any questions on budgeting?

See TT04 Budget, Balance Sheet and Ratios Example

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B. Calculate your Net Worth Using a Balance Sheet

What is a Personal balance sheet?• A financial snapshot of your financial position on a

given date How do you calculate your net worth or equity?

Assets (things you own of value)

- Liabilities (what you owe others)

Net Worth (the value of your holdings)

Note: There are different ways to value your assets and liabilities. Do it correctly!

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Your Assets: What you own

Assets come in many forms:

• A. Monetary Assets• Cash or other assets that can be easily

converted into cash• Provide necessary liquidity in case of

an emergency• Reported at current or market value

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Your Assets (continued)

• B. Investment Assets• Assets, stocks, bonds, mutual funds that

are invested for the future• Used to accumulate wealth to satisfy

specific goals• Reported at current or market value

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Your Assets (continued)

C. Retirement plans• Assets, pensions, IRAs, 401K, etc. by you

or employer• Used to accumulate wealth for retirement• Reported at current or market value

D. Housing • Tangible assets such as land, dwellings,

vacation home, or rental property• Use for personal goals or capital income• Reported at fair market or appraised

value

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Your Assets (continued)

E. Automobiles and Other Vehicles:

• Tangible assets, cars, trucks, and RVs that normally must be inspected and licensed

• Use to meet transportation and work needs

• Reported at “blue book” or appraised value F. Personal Property

• Tangible assets, boats, furniture, clothing, etc.

• These assets represent your lifestyle

• Reported at fair market value, but normally depreciates

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Your Assets (continued)

G. Other Assets: • Any other tangible or intangible assets, business

ownership, collections, hobbies, that may or may not be of value

• Used to fulfill specific personal or business goals and objectives

• Reported at appraised value, but very hard to value

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Your Liabilities: What You Owe

Liabilities come in two major forms:A. Current liabilities

• Liabilities that must be paid-off within the next year.

• Credit cards, utility bills, rent, tuition, books, food, etc.

• Reported at the current amount, plus accrued interest depending on how soon you pay it off

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Liabilities (continued)

B. Long-term liabilities• Liabilities that extend beyond one year

• Student loans, auto loans, home mortgage, consumer loans, credit card debt that you do not expect to pay of within a year, etc.

• Reported at the current amount, although interest rates and when you pay it off will ultimately determine your ultimate payoff amount

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The Difference: What are You Worth Financially (or your Net Worth)

Do you owe more more than you own?• If so, you are Insolvent?

• It may be OK for most students. You are investing now! Keep your spending off credit cards though!!!

• What is a good level of net worth?

• Depends on your goals and your life cycle

• “Good” is relative. Where are you now?

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Your Net Worth

What does your balance sheet show?• Is your net worth growing?• Are you are reaching your goals?• Are you are planning for emergencies?• Do you have adequate liquid assets?• Are you out of credit card and consumer

debt?• Are you saving for retirement and your other

financial goals• If you can answer affirmatively to the

above, you are financially “healthy”

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Questions

Any questions on balance sheets?

Balance Sheet Example

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C. Develop a Personal Income Statement and Use It

What is a Personal Income Statement ?• A financial motion picture of your inflows and

outflows of cash

• It is on a cash basis. The statement is based entirely on actual cash flows, not accruals

• Sources of income:

• Wages, tips, royalties, salary, and commissions

• Income is amount earned, not necessarily amount received. It also includes taxes, health care costs, expenses, etc.

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Expenditures: Where Your Money Goes

Two types of expenses• Fixed expenses:

• Expenses you don’t directly control

• Mortgage, rent, tuition, books, etc.

• Variable expense:

• Expenses you can control

• Food, entertainment, clothing, BYU Creamery, dates, cable TV, new rims for the jeep, new snowboard

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Expenditures (continued)

There can be differences of opinion as to fixed versus variable expenses• One spouse might consider dates each weekend a

fixed expense, while another, variable

• Be careful that variable expenses are not considered fixed

• Most fixed expenses are variable over longer periods of time

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Ratios: A Way to to Analyze Spending

Key Questions to Ask Yourself:• 1: Do you have adequate liquidity to meet

emergencies?• 2: Do you have the ability to meet your debt

obligations?• 3: Are you saving as much as you think you

are?

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Question 1: Do You Have Adequate Liquidity?

These ratios determine whether or not you have enough monetary assets to pay for an unexpected large expense or to tide you over during periods of reduced or eliminated earnings.• Two Key Ratios:

• a. Current ratio

• b. Month’s Living Expenses Covered ratio

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Liquidity Ratios (continued)

1.a. Current ratio• Monetary Assets/Current Liabilities

• This ratio tells you how many times you could pay off your current liabilities with your liquid cash on hand

• Interpretation

• Ratio greater than 2 recommended

• Track the trend and if it is going down --make changes

• Note that this ratio does not consider long-term assets or liabilities

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Liquidity Ratios (continued)

1.b. Month’s Living Expenses Covered ratio• Monetary Assets/Monthly Living Expenses

• This ratio tells you how many months you could survive in the event of the loss of all current income

• Interpretation

• A ratio of 3-6 is recommended. This ratio should at least be equal to how many months it would take to get a new job

• Track the trend and if it is going down --make changes

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Question 2: Can You Meet Your Debt Obligations?

These ratios help determine whether or not you can meet your current or long-term debt obligations:• Key ratios:

• a. Debt ratio

• b. Long-term debt coverage ratio

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Debt Ratios (continued)

2.a. Debt ratio• Total liabilities/total assets

• This ratio tells you whether you could payoff all your liabilities if you liquidated all your assets.

• Interpretation

• This represents the percentage of your assets financed with borrowing

• Track the trend; this ratio should go down with age. A zero debt ratio is a great goal!

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Debt Ratios (continued)

2.b. Long-term Debt Coverage ratio

• Income for Living Expenses/Long-term Debt Payments

• This ratio tells how long you could make payments on your debt based on the amount of money you have for living expenses

• Interpretation

• The higher this ratio the better, as it indicates the longer you could cover your debt payments

• Track the trend; this ratio should go up. Ideally, it is infinity, meaning you have no debt

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Question 3: Are You Saving As Much As You Think?

These ratios determine what percent of your income you are putting to work for you each period through savings and investment• Two Key Ratios:

• a. Savings Ratio

• b. Gross Savings Ratio

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Savings Ratios (continued)

3.a. Savings Ratio• Income for Savings / Income for Living Expenses

• This ratio tells you what proportion of your after-tax income is being saved.

• Interpretation

• U.S. rate typically 3% - 8%

• Track the trend. If it is decreasing, make changes

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Savings Ratios (continued)

3.b. Gross Savings Ratio• Income for Savings / Gross Income

• This ratio tells you what proportion of your total income is being saved.

• Interpretation

• U.S. rate typically 2% - 7%

• Track the trend. If it is decreasing, make changes

• We recommend you save at minimum 10%-20%+ of your gross income if possible, and more as you get older

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Case Study - Part 1

Steve and Mary Jo, both 35, have a yearly income of $50,000, own a house worth $150,000, monetary assets of $5,000, two cars worth $20,000, and furniture worth $10,000. The house has a $100,000 mortgage, they have college loans of 10,000 outstanding, and the cars have outstanding loans of $10,000 each. Bills totaling $1,150 for this month have not been paid ($1,000 is to pay off their credit card that they use for bills). Create a balance sheet for Steve and Mary Jo.

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Mike and Mary Jane have yearly income of $50,000; monetary assets of $5,000; a house worth $150,000; two cars worth $20,000; and furniture worth $10,000. The house has a $100,000 mortgage; the cars have $10,000 each outstanding loans; college loans of 10,000; and utility bills totaling $1,150 for this month, have not been paid.

Assets• Primary residence $150,000• Monetary assets 5,000• Automobiles 20,000• Furniture 10,000• Total Assets 185,000

Liabilities• Current bills $1,150• First Mortgage 100,000• College loan 10,000• Automobiles (2 x $10,000) 20,000• Total Liabilities 131,150

Net Worth (A – L) $53,850

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Case Study – Part 2

Steve and Mary Jo (who make $50,000 per year) calculated their average tax rate at 15%. They contributed 12% of their income to charity and pay themselves 10% of their income. They have 25 years and $100,000 remaining on their 6% mortgage, 3 years and $20,000 remaining on their 7% auto loan, and 10 years and $10,000 remaining on their 3% college loan. In addition, utilities and property taxes were 2,270 per year, food $6,000, insurance 1,500, and other expenses were $5,430. Calculate their income statement for them using the correct method, and round values to the nearest $10.

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Key Information: Salary $50,000 per year, tax rate at 15%, charity 12%, and save 10%. They have 25 years and $100,000 on a 6% mortgage, 3 years and $20,000 on a 7% auto loans, and 10 years and $10,000 on a 3% college loan. Utilities and property taxes are 2,270, food $6,000, insurance 1,500, and other expenses $5,430.

Annual IncomeWages $50,000Taxes (15%) 7,500

Paying the Lord (12%) 6,000Paying Yourself (10%) 5,000Total Income 31,500

Expenses

Mortgage $7,730

Utilities, taxes 2,270

Food 6,000

Insurance 1,500

College Loan 1,160

Car Payment 7,410

Other Expenses 5,430

Total Expenses $31,500

Calculating Annual Expenses

• Mortgage PV=100,000, I = 6%, n=25*12, PMT=? *12 = $7,730

• College Loan PV=10,000, i=3%, N=10*12, Pmt=? * 12 = $1,160

• Car PV=20,000, i=7%, n=3*12, Pmt = ? * 12 = $7,410

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Case Study – Part 3

Assets• Monetary/Current Assets 5,000• Primary residence 150,000• Automobiles 20,000• Furniture 10,000• Total Assets 185,000

Liabilities• Current Liabilities 1,150• First Mortgage (6% 25y) 100,000• Automobiles (7% 3 yr) 20,000• College loan (3% 10 yr) 10,000• Total Liabilities 131,150

New Worth (Assets – Liabilities.) 53,850

Annual Income• Wages 50,000• Taxes

7,500Paying the Lord 6,000Paying Yourself 5,000Total Income 31,500Expenses

• Mortgage 7,730

• Utilities, taxes 2,270• Food 6,000• Insurance 1,500• College Loan 1,160• Car Payment 7,410• Other Expenses 5,430

Total Expenses 31,500

Now that you have their balance sheet and income statements prepared, calculate their key liquidity, debt, and savings ratios, and comment on how well they are doing.

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Key Information: Current/monetary assets $5,000; current liabilities 1,150; Taxes 7,500; Paying the Lord 6,000; Paying Yourself 5,000; Mortgage + related 10,000; Food 6,000; Insurance 1,500; College Loan 1,160; Car Payment 7,400; Other Expenses 5,430

Key liquidity ratios

• Current ratio = current assets / current liabilities

• $5,000 / 1,150 = 4.35 times

• Month’s Living Expense Covered Ratio = Monetary assets / (annual living expenses/12)

• $5,000 / (31,500 / 12) = $5,000 / 2,624 [(M + F + I + CL + CP + OE) / 12] = 1.9 months (Note that annual living expenses in this case does not include contributions or paying yourself)

• They are somewhat liquid. They have a good current ratio (>2) but could only cover annual living expenses for less than 2 months (>3-6+ months is much better)

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Key Information: Total liabilities 131,150; total assets 185,000; total income 50,000; taxes 7,500; mortgage 10,000; college loan 1,160; car payments 7,410.

Key debt ratios• Debt Ratio = total liabilities / total assets

• $131,150/185,000 = 70.9%

• Long-term Debt Coverage Ratio = Income for living expenses/ LT debt payments

• $42,250 (W-T) / (10,000+1,160+7,410) (M+CL+CP) = 42,250 / 18,570 = 2.3 times

• The inverse is 18,570 / 42,250 = 44%

• They have lots of debt--71% of their assets are financed, and their long-term debt ratio is 2.3 times, just below the 2.5 caution level. 44% of their total income available goes to cover debt payments. Just think where they could be investing that money!

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Key Information: Salary $50,000; taxes 7,500; savings 5,000.

Key savings ratios• Savings ratio = income available for savings and

investment / income available for living expenses

• $5,000 (PY) / 42,250 (W-T) = 11.8%

• Gross Savings ratio = income available for savings and investment / gross salary

• $5,000 / 50,000 = 10%

• They are saving 11.8% of their income available for living expenses, and 10% of their gross salary. This is OK, but should be the minimum amount.

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Ratio Summary

Overall situation Actual Recommended Liquidity

• Current ratio 4.4 times > 2• Month’s living expense covered ratio 2.3 times > 3 – 6+

Debt• Debt ratio 70.9% 0% (Note 1)• LT debt coverage ratio 2.3 times > 2.5• % income to pay debt 44.0% 0% (Note 1)

Savings• Savings ratio 11.8% > 10%• Gross savings ratio 10.0% 10% min (Note 2)

Notes: 1. Depends on your age. Ideally, it should decrease to zero2. While the minimum is 10%, it should increase as the situation allows

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Current ratio 4.4 times > 2 Month’s living expense 1.9 times > 3-6+Debt ratio 70.9% 0% LT debt coverage ratio 2.3 times > 2.5Savings ratio 11.8% > 10% Gross savings ratio 10.0% 10% min

Recommendations: • Somewhat liquid, but carrying too much debt (71%).

• Purchased too much on credit--need to slow purchases substantially or sell some assets

• They are saving money; however, they could be saving more.

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Final thought

Elder Joseph B. Wirthlin commented:• I advise you to be patient in financial matters.

Avoid rash or hurried financial decisions; such decisions require patience and study. Get-rich-quick schemes seldom work. Beware of debt. Be especially careful of easily obtained credit even if the interest is tax deductible. You young couples should not expect to begin your married lives with homes, automobiles, appliances, and conveniences comparable to those your parents have spent years accumulating. (Joseph B. Wirthlin, “Patience, a Key to Happiness,” Ensign, May 1987, 30.)

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Review

A. Can and will you develop and implement a budget?

B. Can and will you calculate your net worth (wealth) using a balance sheet?

C. Can and will you develop a personal income statement and use it to analyze your spending?